Analyst weighs in on Apple's rev-share arrangement with AT&T

Due to the unique terms of iPhone sales and pricing, analysts for Piper Jaffray said Thursday they believe AT&T has agreed to a revenue sharing plan with Apple where the iPhone maker would receive a small portion of each subscriber's monthly service fees.

"While we do not know the exact details of the agreement, we conservatively estimate that AT&T gives Apple $3 per month (over the life of the 24 month contract) for every iPhone customer already with AT&T and $11 per month for every new subscriber," lead analyst Gene Munster wrote in a note to clients.

Specifically, the analyst believes the monthly revenue sharing involves $3 per month for service and data fees related to all iPhone users, and AT&T gives Apple an additional $8 per month for iPhone customers who transfer service to AT&T in order to use the iPhone. Such an arrangement, he said, could add 2 cents to his per-share earnings estimates for Apple in 2007, 15 cents in 2008, and as much as 58 cents in 2009.

Clearly, Munster explained, Apple's average revenue share per iPhone user depends significantly on the mix of current versus new subscribers. He cited an in-house June 29 survey of 253 iPhone users, which found that 52 percent were switching from a carrier other than AT&T.

"Our survey, however, consisted mostly of early adopters who would be more willing to cancel non-AT&T contracts than the general customer base," he wrote. "For that reason, we estimate for the mix of iPhone users that are new to AT&T will drop from 52 percent in June to 44 percent in the September '07 quarter and continue to drop over time as AT&T gains an iPhone user base."

Munster is modeling for Apple to sell 3.2 million phones in 2007, 12.4 million in 2008, and 45.0 million in 2009.

"These estimates may seem bold, but we believe Apple can garner 7.0 percent of the handset market share in North America and 2.8 percent share in the rest of the world by 2009," he told clients. "We assume Street pricing on the iPhone will have dropped to $338 by 2009 from $542 in 2007. Additionally, it is critical to keep in mind that the iPhone combines iPod and mobile handset, which should attract more than just a mobile phone customer."

As part of his model, the Piper Jaffray analyst has factored in cannibalization of the iPod from the iPhone by lowering iPod growth rates from 35+ percent yearly growth in fiscal 2007 (and prior years) to 10 - 15 percent in fiscal 2008 and 2009.

Munster made no changes to his Outperform rating and $160 price target on shares of the Cupertino-based electronics maker.

Do any other handset manufacturers have revenue/profit sharing agreements with mobile carriers?

As far as we know, nope. The typical subsidy has the carrier paying the manufacturer for each sale and that is where it ends. This new paradigm of Apple having a vested interest in the longevity and usefulness of the iPhone means that we can expect more updates and changes to both the handset and the network. Apple's new 24-month accounting system for the iPhone also points to this.

This type of revenue-sharing arrangement would make sense given the exclusivity of the iPhone to AT&T. If there were no monetary incentive for Apple, they certainly wouldn't bother putting a lot of engineering effort into locking the iPhone hardware to the AT&T network.

Yes, I have an iPhone in Canada and am just whining because I can't get it working on Fido.

As far as we know, nope. The typical subsidy has the carrier paying the manufacturer for each sale and that is where it ends. This new paradigm of Apple having a vested interest in the longevity and usefulness of the iPhone means that we can expect more updates and changes to both the handset and the network. Apple's new 24-month accounting system for the iPhone also points to this.

What about RIM? I think they do provide a bit of service to actually justify it though.

"Our survey, however, consisted mostly of early adopters who would be more willing to cancel non-AT&T contracts than the general customer base," he wrote. "For that reason, we estimate for the mix of iPhone users that are new to AT&T will drop from 52 percent in June to 44 percent in the September '07 quarter and continue to drop over time as AT&T gains an iPhone user base."

This analyst is placing too much weight on early adopters who terminated their contracts, and then switched to AT&T, as a basis to claim that future iPhone purchasers that are "new to AT&T" will decline, and that the sales numbers will come from AT&T customers upgrading later on.

He is totally ignoring the fact that there may be a huge pent up demand from people with less than six months left on their current contract and that they are waiting to switch to AT&T once their contract with their current provider is finished.

I would not be surprised to see the "mix" of customers new to AT&T climb over the next few months, and not the substantial decline he proposes.

Well, the big deal here would be what Apple is getting for people who switch to AT&T. $264 over 24 months comes across as pretty good. I don't know what it is these days, but a 2 year contract used to equal around $200 off on a phone. $72 over 24 months for non-switchers, isn't that great of a deal for Apple, seems like way less than the phone manufacturers would traditionally get. But as someone else said, maybe that's just more incentive for Apple to keep this iPhone model useful beyond two years (or to buy the next model iPhone).

Reading this makes me believe we are going to be stuck with the iPhone as AT&T only in the US for quite a while.

This is huge, indeed, if true. What's not huge is Munster's math abilities. This would mean a lot more than 15c next year--he's off by 10x! Here's the real math:

Without debating the exact mix of switchers off other services vs. existing AT&T customers, assume an average cut for Apple of $7.50/month. If you have 15 million subs throwing off $7.50/month * 12 months = $1.35 BILLION in profit to Apple per year. With approx. 880 million shares outstanding, that's around $1.50/share, not 15 cents! MAJOR DIFFERENCE!

If you are not already a shareholder, you should seriously considering doing so. If this news is confirmed by Apple (the revenue share arrangement) next week at earnings announcement, this would kick in around $45/share in price over the current estimates driving the stock price...the market is giving Apple 30 x forward earnings per share. 30 x $1.50 = $45/share added to current picture. Obviously, some people are anticipating this news and running up the share price, but when the lead guy on Apple at Piper Jaffray can't even do simple math, it tells you that there are a lot of upside surprises in store for the stock.